Internal Affairs Doctrine: California versus Delaware in a Fight for the Right to Regulate Foreign Corporations

Abstract

In the United States, a prospective corporation is free to incorporate in any state, regardless of where the corporation plans to physically locate or transact business. Where the corporate organizers reside and whether or not the corporation has any actual ties to the chosen state of incorporation are factors of no consequence. The state that a corporation chooses is extremely important, however, because states generally have the exclusive right to regulate the internal affairs of corporations that have decided to incorporate under their laws. This sole right of regulation is known as the Internal Affairs Doctrine (IAD), which replaces the standard conflict-of-laws principles that apply in most other areas of law. Several states have recently decided to resist this seemingly absolute right of an incorporating state to regulate internal affairs. Most notably, in 1977, the California legislature enacted Corporations Code section 2115. This statute allows the state to regulate all corporations that conduct a majority of their business in California, even if they are incorporated out-of-state and are considered foreign corporations. The statute's purpose is not to eliminate or override the regulatory rights of the actual incorporating state, but only to add another layer of protection for California shareholders and stakeholders in those foreign corporations. Section 2115 has been approved and upheld by the courts in California. Delaware courts, on the other hand, have whole-heartedly disagreed with allowing non-incorporating states to regulate internal affairs. They refuse to permit any exception to the IAD and have criticized California's section 2115 in its entirety. The fact that these two specific states are diametrically opposed on this issue is extremely important because they are two major players in corporate law. More than sixty-percent of all Fortune 500 companies are incorporated in Delaware, and twenty-percent of all Fortune 500 companies are headquartered in California. Consequently, the unsettled nature of the law governing internal affairs affects a substantial number of the largest corporations in the country. This Note argues that California Corporations Code section 2115 should be accepted as a valid exception to the IAD, and that in certain situations, a non-incorporating state should have the right to regulate foreign corporations operating significantly within it. Part I examines the history of this type of regulation in California and traces the state's steps in creating section 2115. Part II discusses relevant case law from other jurisdictions that have adopted similar schemes of regulation. Part III examines the history of the treatment of the IAD as a categorical rule in Delaware. Part IV summarizes the problem of having competing state policies regarding the regulation of corporate internal affairs through a discussion of the Supreme Court of Delaware's decision in VantagePoint. Finally, Part V highlights this court's error through a critique of its VantagePoint opinion and questions the real motives driving Delaware's decision to reject section 2115 as an exception to the IAD.